CIS Financial Planning
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Stock Picking
The next step is to determine if you should buy XYZ or ABC stock. Again, you need to start with a top-down approach. You need to know if the market itself is a good value or not. This is determined by a number of factors including price/earnings ratio (P/E), dividend yield, price/book ratio and price/cash flow ratio, among others. The market normally trades with a dividend yield of about 4 -5% and a P/E ratio of 13. A dividend yield under 3% indicates substantial risk, over 8% would be low risk. A P/E ratio over 18 is high risk., under 10 is low risk.

Each industry has its' own set of variables that indicate value. Growth companies tend to trade at P/E multiples over 20, banks tend to have P/E's under 10. It is important to know how the stocks within an industry trade. Sometimes there can be a wide variance of P/E ratios and dividend yields within an industry group. A little bit of research usually will clear up the disparities.

Now, finally, (if you've read this far you get bonus points) you can start to pick stocks. You have a firm economic view, you have determined the best industry groups, now you can pick out the stocks within the groups. The list should be relatively clear which are the best values.

Now is the tough part. You can't let emotion get involved. Just because XYZ might be your favorite company, if the stock is overvalued, you should not buy it. This is the toughest concept for any investor to understand. Not all good companies have good stocks. A company can be great on paper, but it's stock be a dog. Thanks to the cyclical nature of the stock market, today's overvalued hot stock can become tomorrow's overlooked, undervalued gem. Just because a stock is overvalued today, don't ignore it, you may get a buying opportunity in the future if the stock drops. (Assuming the fundamentals have stayed the same)

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